Thinking About Taking the Home Office Deduction? You Might Owe the IRS Later!
How Depreciation Recapture Can Cost You and Two Strategies to Avoid It
The home office deduction is often a no-brainer for physicians who own their medical practice or have side gigs. It reduces taxable business income and thereby indirectly lowers your adjusted gross income (AGI), potentially helping you qualify for certain tax credits, such as the EV credit.
While using a home office to reduce taxable income is a legitimate and widely used strategy, it’s important to understand the potential downside - you may have to repay the IRS for the depreciation you claimed in the form of depreciation recapture when you sell your home.
At the end of the day, there’s no such thing as a free lunch, right?
So today, I’ll focus on this issue and share two strategies you can consider to avoid depreciation recapture.
Two Ways to Claim a Home Office Deduction
Option 1: Simplified Method
As the name suggests, this is the easier way to claim a home office deduction, but the deduction amount is modest—$5 per square foot of home office space, up to a maximum of $1,500 annually. This means you can claim a home office deduction for up to 300 square feet under this method.
For example, if you use 300 square feet of your home as a home office, you are entitled to a $1,500 business deduction, which reduces your taxable business income by $1,500.
Option 2: Actual Expense Method
This method generally results in a larger home office deduction since it allows you to deduct depreciation on the home office portion of your home, along with a proportional share of expenses such as utilities, property taxes, and maintenance.
For example, let’s say you live in a 1,000-square-foot home in an expensive part of Manhattan that you purchased for $2,000,000. If you use 10% of your home (100 square feet) as a home office, your deduction under the actual expense method will be significantly higher than with the simplified method.
Home Office Deduction Calculation (Actual Expense Method) for 2025
Property cost: $2,000,000
Building value: $1,000,000 (assuming the remaining $1,000,000 is allocated to land, which isn’t depreciable)
Home office portion: 10% (100 sq. ft.)
Depreciation: 10% of $1,000,000 = $100,000 over 39 years → $2,500/year
Property taxes: Assuming $30,000 annually, 10% → $3,000 deductible
Mortgage interest: Assuming a $1.5 million mortgage at 7%, which results in $100,000 in mortgage interest annually, 10% → $10,000 deductible
Utilities & other expenses: Assuming $1,000 annually, 10% = $100 deductible
Total Annual Home Office Deduction:
$2,500 (depreciation) + $3,000 (property taxes) + $10,000 (mortgage interest) $100 (utilities & other expenses) = $15,600
This is significantly more than the $500 deduction under the simplified method for a 100-square-foot home office.
The Catch: Depreciation Recapture Upon Home Sale
If you sell your home after claiming a home office deduction using the actual expense method, the IRS will require you to “pay back” the depreciation you took on the home office. This is known as depreciation recapture. In this case, it is taxed as unrecaptured §1250 gain, which is a form of capital gains, at a maximum rate of 25% rather than your marginal income tax rate.
Example:
If you’ve claimed $50,000 in home office depreciation deduction over the years, you will have to report $50,000 as depreciation recapture income upon selling your home. This amount will be taxed at a maximum rate of 25%, resulting in a $12,500 tax liability.
Silver Lining
When you pay back the depreciation, it is taxed at a lower 25% rate rather than your marginal tax rate, which could be as high as 37%.
Additionally, the tax you pay back years later is done so with dollars that have depreciated in value due to inflation - meaning you effectively pay with money that is worth less in the future (a benefit of the time value of money).
Bottomline
Since the original deduction reduced your business income— which would have been taxed at your marginal income tax rate (potentially 37%)— you often come out ahead because the recaptured depreciation is taxed at a lower 25% rate. Additionally, you’re paying back the tax with future dollars that have depreciated in value due to inflation.
That said, it’s still important to plan for the future tax bill when selling your home to avoid unexpected liabilities.
Two Strategies to Avoid Depreciation Recapture
1. Use the Simplified Method
Since the simplified method doesn’t involve depreciation, there’s no depreciation recapture when you sell your home. While this method provides a smaller deduction, it eliminates the concern of paying back depreciation later.
2. Hold Onto Your Home Until Death (Death Strategy)
If you never sell your home, depreciation recapture won’t be an issue. Upon death, your spouse (in a community property state) or heirs will receive a stepped-up basis, which eliminates all past depreciation deductions - meaning no recapture tax will be due.
By using one of these two strategies, you can avoid depreciation recapture entirely while still benefiting from the home office deduction.
Final Thought
The home office deduction can be a valuable tax-saving tool, but you should also consider the tax consequences down the line.
Disclaimers: click here